Banking System - Fractional Reserves
I am a citizen of the Czech Republic, in the so called “Heart of Europe”, a neighbor of Germany, part of the European Union. We still have our own currency – Czech Crown (Koruna Česká) – but our banking system is similar to the USA Federal Reserve System, although we have only one Central Bank – the Czech National Bank (CNB). I hope that this will prove better for understanding as it is not so complex, but still uses the same mechanisms.
After watching videos on the Internet and those spread by this community, I really believed that the system has built-in unpayable debt, but I did not stop there, I was searching a bit more…
M0 Monetary Base - Not all money is debt
The CNB has gold deposits and the right to emit real paper banking notes. This, together with reserves, is called a monetary base or M0 – the highest liquidity. You may still think of it as “the gold in the national vault”, but it should in general truly mean “basic national wealth” as this is not only about gold, but rather about the real economic strength, which should be growing in time, and it corresponded to gold mining in the past. Keep in mind that the population is growing as well as production thanks to technological progress.
M1 Money Supply – Debt-money is a controlled sharing system
Think of it as sharing/distribution of excess production which was not consumed yet. Let’s start with 100 000 CZK in your hand, which means that you can use 77g of national gold for trading, but the new holder must return it immediately and take another “gold note”. This is a virtual money trade scenario – you will never have those 77g in your hand, only the note. Now, you put your 100 000 CZK into a commercial bank for sharing, which means that you delay your consumption and are willing to share this excess production (you earned your money for work). The bank will put 2 000 CZK in the CNB as its required reserve (CNB can adjust the ratio up to 30 percent but it currently is 2 percent; in the USA it is 10 percent for big banks) and will lend your 98 000 CZK to somebody with a good idea but short of cash. He will buy new equipment and start producing and paying back the loan. The new owner of those 98 000 CZK can put it into the bank as well and the bank will put 1 960 CZK in the CNB and lend 96 040 CZK. This can go indefinitely, but the ratio of total reserves:loans:deposits will always be 1:49:50 and will never exceed 100 000 CZK in reserves (the input deposit/first real emission from CNB), 4 900 000 CZK in loans and 5 000 000 CZK in deposits. Note, that without interest, all debts are perfectly payable and commercial banks have absolutely no money from it. All this can easily shrink to the original 100 000 CZK when all debts are paid.
Interest and Bank Expenses
Banks need a way to pay their expenses, to pay people for their jobs, to buy buildings, computers, etc. If the interest is perfectly balanced with expenses, all loans are payable. Imagine it as water-pipes: the central bank is the main container and emits real money and receives reserves. It can also emit loans (1.5 percent) and deposit interest (0.25 percent discount, 0.5 percent two-week repo op.) as well as some expenses while receiving loan interest, deposits and destroyed bank notes. Commercial banks receive deposits and loan + interest payments, emits loans and real expenses (wages, costs for running). It is a perfectly closed system, if all interest is well balanced with expenses – water=money freely circulates in the system, no shortages…yet.
The Real Problem
There are actually two problems: a) the balance between expenses and interest payments b) bankruptcies and loans not paid back. The first problem should be handled by free market – if any bank sets their loan-interest too high and deposit-interest too low, they lose customers. The second problem should be handled by careful quality-checks, central debt databases and slightly higher loan-interest to pay the losses back (mortgage interest is low because the building is used to repay the loan in case of problems).
The Big Casino
To make big money, you have to risk, but this is not only about banks, it is about all business and general behavior. Do not blame the money-system itself, others are to blame – the real people hiding the truth behind the free market: the competitive behavior, maximization of profit, artificial scarcity scenarios – this is not about money - the fractional reserve system is actually anti-scarcity - this is about resources and unfair speculative attacks and bad investments!
Commercial banks owned by the government, lending money at low interest to big long-term projects needed for the economy, grants basic income for everybody, with tax reform to produce a real progressive, transparent and simple tax system, reduction of “the Heavy Foot of Government”, standardization, cooperation, innovation and technology.